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How To Find True Costs Of Goods

Fishbowl CMO Kirk Tanner explains how to calculate all of the costs that go into every product a business sells.

In Fishbowl's Whiteboard Wendesday videos, Fishbowl CMO condenses complex inventory management and accounting subjects into terms that are simple enough to fit on a whiteboard.

In this video, Kirk explains how to calculate your true cost of goods. This includes consistently using the same accounting method, such as FIFO, LIFO, Average Cost, or Standard Cost and then factoring in Landed Costs and various costs of production.

We’ve got some accounting methods here. These are cost accounting methods. The first one is FIFO, which is First In First Out. And it’s literally what it says for the accounting purposes and establishing a price. Imagine this is a conveyor belt and red comes into inventory, orange, then green. It means that if the red was in first, the red one goes out first. So first in, first out, and that’s how you establish your pricing for the products that you’re gonna sell.

This is a really simple method that works well, very common in small and medium businesses. The downside is it may not be very accurate relative to the market, so there might be some variance here. But it is a common method that’s used.

Then we’ve got Average Pricing. You’ve got this product that you’re buying over time, and the price will vary, but you’re just gonna figure out an average and establish that as the baseline price.

The positive is it’s very stable because you’re basing it all on an average. It makes it really simple. The downside is that your returns and your waste, well, they don’t really reflect the actual cost of goods. It’s just an average cost.

But those two methods are, by far, the most common in small and medium-size businesses. There are two other methods that we’ll mention just so you’re aware of them, but they’re not as common.

The first one is LIFO. And LIFO is exactly the opposite of the First In First Out concept. In this one here, the last one in is the first one out.

Standard Pricing means that you’re using industry standards. Regardless of what the price actually was, you’re basing it on more of what the industry is looking at and what the market will bear. Again, not really common in small and medium businesses, but it is one of the accounting methods.

So, whichever one you use, and it’s gonna vary based on your business, that is your baseline cost of goods.

But we have some other costs that we have to factor in to get to the true cost of goods. And that starts with Landed Costs. Whatever it is that you’re selling, manufacturing, distributing, you’ve gotta get materials, parts, inventory to your location. So that can be a number of different ways, from trucks to planes to boats. But you’ve got taxes, tariffs, and fees that are all related to getting that product to your physical location. So you’re gonna identify those Landed Costs.

Then we’ve got one more element that we’ve gotta factor in, and that is Bill of Materials. No matter whether you’re selling something, manufacturing, distributing, you’ve got some time and you’ve got some labor that’s associated with your business. And you’ve got fees, like merchant services, your own rent, insurance, and things like that. You’re gonna want to take a portion of that and bring it over as your Bill of Materials.

Then, once you have established that, you can come back to your cost up here, you can add in your Landed Costs, you can add in that element of the Bill of Materials, and you can establish a true cost of goods so that then you can establish the margin, the price that you want to sell that product for to ensure that you have a nice profit margin in there that allows you to invest in your business going forward, and be successful.

Now, this is simplified. It’s a relatively complex process of establishing this true cost. What we recommend is that you talk to your accountant and determine which one of these is gonna work best for you and determine how best to add this in to establish your true cost of goods because every business is different. But that is basically your true cost of goods.